Freedom at What Cost? Economic Inequality and Prosperity in the Modern World

The history of humanity consists of alternating periods of growth and decline in wealth inequality. Relatively egalitarian primitive communities evolved into hierarchical societies, such as those in ancient Egypt, Persia, and Rome. In other words, hunters and gatherers in the Stone Age did not have the conditions to accumulate wealth, they did not produce too many goods – so they lived in an equal society.

After the transition to a sedentary mode of life, they began to accumulate material goods (being subject to inheritance), and over time, to secure them, they created laws and institutions. This led to an increase in social inequalities, which flattened out again after aggressive contraction: war, rebellion, revolution, etc. For example, the fall of the Roman Empire brought about a leveling of living standards, eliminating significant wealth disparities. However, it was a leveling-down, from which Western Europe spent many centuries recovering.

Mainstream economists mostly admit that the rise of social inequality in the late Middle Ages and subsequent epochs determined faster development. It also allowed Christian Europeans to outdo Muslim Arabs, who had previously dominated both scientifically and economically (the golden period of Arab culture lasted from the 8th to the 10th century AD).

Some scholars see the reasons for the economic success of Christians, who achieved it at the expense of Muslims, in the law. Faithful to the book of the Quran, the Arabs cared about the fair inheritance of property: to prevent fratricidal fights, family disputes and lawsuits, they assumed that the testator could freely dispose of one-third of the property, while the remaining two-thirds were divided equally among the living family members (regardless of gender). In contrast, in the circle of Christian culture, solutions known from Roman law were adopted, where inheritance was 100% based on the will of the testator.

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The consequences were as follows: Among the Muslims, there was an increasing fragmentation of wealth and dispersion of capital, while in the Christian world, there was an accumulation of it. The pooling of assets caused “returns to scale” and made it possible to get rich faster. One of the beneficiaries of this phenomenon was the Catholic Church, which managed an increasing area of land. After the 13th-century changes in agriculture (among others, the prevalence of the plow with an iron moldboard), when productivity increased several times, the dignitaries and magnates began to accumulate huge estates.

Thanks to their financial surpluses, culture, art, as well as science and inventiveness with time developed. It was the wealthy magnates who laid the foundations for the Renaissance – including, among others, the dissemination of printing, the Reformation, etc. The situation was repeated in the following centuries, when after the Baroque, supported by the Catholic Counter-Reformation, the Enlightenment broke out, bringing, among others, an industrial revolution. It resulted in huge fortunes that made it possible to implement reforms, such as universal education. Thanks to the richest, the poorest also gained opportunities.

There is no such thing as a fair state

Nowadays, in the era of “political correctness,” the public debate is dominated by the postulate of the necessity of equalizing opportunities and eliminating wealth inequalities. This is evidenced by the almost universal acceptance of the progressive tax system (the better earners pay proportionally more, and the poorer are usually exempt from this duty). In addition, especially in Europe, a generous system of social benefits, financed by the taxes of working people, is being expanded. There have been several experiments with unconditional basic income, that is, paying each citizen a certain amount of money “for nothing” (without requiring any activity). Economists, who remember the failed experiments with communism in Eastern Europe, look at these actions with horror.

It is worth bearing in mind that the neoliberal school, identified with the Chicago School, was formed in the interwar period under the influence of emigrants from Central Europe – Ludwig von Mises, Friedrich Hayek, Joseph Schumpeter, Karl Popper and Peter Drucker. They remembered the struggles of the populist left and right in Austria and Germany, the dramatic experiences of the Great Depression, and finally, they witnessed the grim march of fascism and communism. This led them to conclude that the best way to defend liberal democracy and open society is to minimize the role of the state in the economy.

Hayek put it bluntly that the government’s attempt to implement the idea of social justice is not only impossible but also harmful. It is based on preconceived assumptions about the “importance” of specific activities or professions (e.g., it values the effort of “uniformed” more than civil officials, underestimates teachers, etc.). In such a situation, the opinion about what is fair becomes the result of brutal horse-trading between interest groups, rather than a consensus on universal principles. The Austrian economist contrasts distributive justice with cumulative justice, which is the result of the market process. Hayek concludes that economic inequality is a price worth paying in the name of individual freedom. Otherwise, putting economic security above the need for freedom means taking a path that leads to collectivization, totalitarianism and enslavement.

Competition fuels growth

The acceptance of income inequality by mainstream economists (neoliberals) is confirmed by the concept of Pareto efficiency. Vilfredo Pareto, an Italian economist of the turn of the 19th and 20th centuries, argued that in the conditions of competition, there is an optimal allocation of resources, ensuring the greatest possible social well-being. In other words, it is a condition in which the production (or consumption) of one good cannot be increased without reducing the production (or consumption) of another good. Therefore, it is impossible to improve the well-being of anybody without harming the well-being of someone else.

For this reason, neoliberals hold the view that the level of wages and their differentiation result from the laws of the competitive market. The amount of wages is determined by the marginal productivity of labor. Individual productivity, in turn, depends mainly on human capital, which is directly related to professional qualifications.

Aside from the previously mentioned, there are other reasons why, according to mainstream economists, wealth inequality is beneficial for economic growth. They point out that the propensity of rich people to save is greater than that of the poor, hence economies with high inequalities have an advantage in terms of investment opportunities. Another argument is the concentration of capital, which ensures the indivisibility of investments. When wealth is concentrated in one hand, it is easier to finance all expenses and focus on development. Yet another argument concerns motivation: a policy of reducing inequality through income redistribution or intervention in the labor market (e.g. imposing a minimum wage) lowers the incentive to accumulate capital and seriously weakens the desire to earn.

The conclusions drawn from the above theses are simple: the pressure on equal pay is negatively correlated with effectiveness (weakens it). A state’s policy of spending public funds on the equalization of income results in a decrease in micro- and macroeconomic efficiency. Sustainable economic growth is therefore the most effective way to improve the situation of the lower earners.

Equalizing opportunities can be beneficial

Mainstream economists assume the existence of free competition. However, in the modern world, where economic activity is limited by more and more detailed legal regulations, competition between economic entities is not a simple game of interests. Firstly, there is increasing legislative chaos – new regulations, permits, concessions, etc. are being created. Secondly, the producer groups organize themselves to limit competition. Thirdly, individual countries, acting in the interest of domestic companies, fight against “foreign” business rivals. We are therefore very far from the ideal free market that the neoliberals talk about.

The experience of the past years, which began with the 2008 financial crisis, has prompted many economists to take a new look at the economy. It was supposed to take greater account of the social context. “Not paying enough attention to the distribution of income is one of the main objections to modern economics,” said Prof. Andrzej Wojtyna from the Krakow University of Economics, a former member of the Polish Monetary Policy Council. This claim was to be confirmed by – and supported by empirical research – the increasing divergence of economic growth indicators (GDP) with assessments of changes in the quality of life or the well-being of the population.

Economists pointed out that the imperfection of the credit and insurance market, but also human capital, meant that poorer people had limited opportunities to invest – including in their education (social capital). For this reason, many talents have not been used properly. And this loss of social capital has significantly slowed down the economic growth possible to achieve.

In addition, rising income inequality has negatively affected the stability of the economy, as the level of savings of only a small group increased. This created conditions for fluctuations in general demand and economic situation. To sustain demand from lower-income earners, a policy of credit expansion was pursued, which ended in a debt crisis. Capital surpluses were used simultaneously for risky financial operations and speculation. To sum up: the financialization of the economy has led to the creation of speculative bubbles in the asset markets (e.g. stocks or real estate), which has greatly increased the vulnerability of the economy to crises.

Arguments against the growth of inequality were also related to the improper structure of demand: with high wage inequality, economies fell into the trap of low wages, low social capital, and consequently low growth. This was because entrepreneurs had no motivation to modernize their technology. After all, they would not find the consumers for their goods. This situation occurs mainly in Latin American countries (high inequality, low development).

From a social economy point of view, too much of a wage gap also causes social conflicts and political instability. Excessive concentration of income leads to the emergence of lobbyists interested in corrupting a part of society, which does not serve the well-being of society as a whole.

Where are the limits of redistribution?

The policy of equalizing opportunities has thus become an inseparable element of the state’s actions. While it is difficult to oppose its effects in the field of education (thanks to this it is possible to pick talents up), in the field of all kinds of benefits, endowments or subsidies it arouses more and more emotions.

Not only did groups of French and Germans, but also Swedes, famous for their exaggerated political correctness, protest against excessive redistribution. At elections held in this Scandinavian country in 2022, the Sweden Democrats came second, openly opposing the universal payment of social benefits, especially to refugees. Even more important than the party’s electoral success was the fact that the issues of eliminating “non-western” districts and inclining emigrants to take up work permeated into the public debate. This issue had been dealt with earlier in Denmark.

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Even before the announcement of the COVID-19 pandemic in Europe, there were demands for the introduction of a universal basic income, to which every citizen is entitled in a similar amount, regardless of their financial situation. However, recently the issue has been forgotten. Admittedly, in Switzerland, 100,000 signatures were collected for a referendum request on the matter, but the vast majority of voters (77%) opposed the idea in 2016. In Finland, an experiment was launched in 2017 to pay EUR 560 to homeless people (even after finding a job); in 2019, the government decided to end it.

If the tendencies in economics – somewhat similar to those in literature or art – are sinusoidal, it seems that after a period of vogue for state intervention and the elimination of wealth differences, we are again dealing with libertarian tendencies. The post-covid crisis and high inflation have partially reduced the wealth gap. Those who have accumulated cash resources have less in real terms today than they did a few years ago. It seems that the views of the Scottish philosopher, the patron of liberals – Adam Smith,  are coming back into favor. Nearly 250 years ago he propagated that wealth comes from work. Not from benefits.

Translation: Marcin Brański